The stock market is on cruise control, slowly drifting up, like driving with hands off the wheel. While few immediate negative market events are on the horizon, the market is expected to continue its flight.
When will the party stop?
Over 30% gains in the S&P 500 last year wasn’t enough. We want – NO, WE NEED – more capital accumulation. But how far are we willing to go? The market is already overvalued more than 60% compared to historical earnings. You can check out and learn more about the Shiller PE Ratio here. If you don’t trust legendary Yale professor Robert Shiller’s index, then maybe you can trust Warren Buffet’s single best measure of stock market valuation – by taking the total market cap (TMC) and dividing it by the total gross domestic product (GDP). Today the TMC is 114.5% while the historical mean is 70.7%.
What will cause the correction?
Some hold the view that once quantitative easing ends, interest rates will rise quickly, demand for goods and services will be hindered, and the economy will slow. Others think that inflation will take off – but I personally do not think this is likely in the near/immediate term. This is because a lot of wealth generated from stock market capital gains is concentrated at the top, and those capital gains are not being spent on goods and reducing supply, but instead being reinvested in the market. I believe that when consumer spending increases (which has been modest), labor supply tightens (there’s still lots of slack in many industries), and wages move upwards (and they have remained flat), that’s when we will see inflation rear its head. That being said, I do think gold, the fear/inflation gauge, is a good long-term investment at current price levels.
Ultimately there’s no telling what will cause the next correction. We can only speculate – as always. But we do know that the market is overvalued from historical market indicators. I’ve seen many arguments that sentiment will drive us higher. When the argument is based on something other than economic data, it is a good indication a bubble is in the making or has arrived. For the time being, many wealth managers are still expecting high single digit growth in the market this year.
What do you think? Do you think the market is overvalued, and if so, what will cause the market party to end?